How to Read a Profit and Loss Statement and Balance Sheet
How to read a profit and loss statement and balance sheet each month: a worked example in pounds, a month-end review checklist, and the changes that deserve a closer look.
Mathias Popp
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In short
A profit and loss statement (P&L, or income statement) shows revenue, costs and the profit or loss left over for a period, usually a month.
A balance sheet shows what the business owns, what it owes and what belongs to the owners on one date. It always balances: assets = liabilities + equity.
The two connect through retained earnings: the month's net profit is added to equity on the balance sheet, and dividends or owner drawings are taken off.
Read both together after every month-end close, compare them with last month and with budget, and treat any sharp change as a question to answer, not a verdict.
A cash flow statement is the third statement. It explains why a profitable month can still leave you with less cash, and is only touched on here.
What a profit and loss statement is
A profit and loss statement reports the revenue a business earned and the costs it incurred over a defined period, and ends with the net profit or loss for that period. In the UK it is also called an income statement; in Denmark it is the resultatopgørelse. For a limited company it is one of the statements filed in the annual accounts.
The statement works down in steps. Revenue minus the direct cost of delivering what you sell gives gross profit. Gross profit minus operating expenses such as wages, rent, software and marketing gives operating profit. Interest and tax then bring you to net profit. A monthly P&L shows the final figure and every line that produced it.
What a balance sheet is
A balance sheet shows what a business owns, what it owes and the owners' stake at a single date, usually the last day of the month. Where the P&L covers a period, the balance sheet is a snapshot. In Denmark it is simply the balance. Every balance sheet satisfies the accounting equation:
Assets = Liabilities + Equity
Assets are cash, trade receivables (invoices customers have not yet paid), stock, prepayments and equipment. Liabilities are trade payables, VAT and PAYE owed, accruals and loans. Equity is share capital plus retained profits, less losses and dividends.
Current assets are expected to turn into cash within a year and current liabilities fall due within a year. Anything longer is non-current: equipment, and the part of a loan due after twelve months.
How the P&L and balance sheet connect
The P&L is prepared first, because its net profit updates equity on the balance sheet. Net profit for the month flows into retained earnings, the cumulative profit the business has kept rather than paid out. The roll-forward is:
Opening retained earnings + net profit − dividends or drawings = closing retained earnings
A company starts April with £45,000 of retained earnings, makes £10,500 net profit and pays a £5,000 dividend. Closing retained earnings are £50,500. The £10,500 appears as net profit on April's P&L; the £50,500 appears inside equity on the 30 April balance sheet.
Dividends and owner drawings reduce equity. They are not expenses, so they never reduce net profit on the P&L. Which equity account they hit depends on whether you trade as a limited company or a sole trader; HMRC's guidance on taking money out of a limited company sets out the options.
Profit and loss statement example
Brightside Design Studio, a UK service business, earned £50,000 in April. Each line is also shown as a percentage of revenue (vertical analysis), so margins can be compared across months of different sizes.
April P&L | Amount | % of revenue |
|---|---|---|
Client revenue | £50,000 | 100% |
Project contractors | (£10,000) | 20% |
Project delivery software | (£2,500) | 5% |
Cost of sales | (£12,500) | 25% |
Gross profit | £37,500 | 75% |
Wages and employer costs | (£15,000) | 30% |
Rent | (£3,000) | 6% |
Marketing | (£2,500) | 5% |
Insurance and utilities | (£1,500) | 3% |
Depreciation | (£1,000) | 2% |
Operating expenses | (£23,000) | 46% |
Operating profit | £14,500 | 29% |
Interest received | £100 | 0.2% |
Interest paid | (£600) | 1.2% |
Profit before tax | £14,000 | 28% |
Corporation Tax (estimated) | (£3,500) | 7% |
Net profit | £10,500 | 21% |
Contractors and delivery software sit in cost of sales because Brightside uses them directly to complete client work. Gross profit is what remains after those direct costs. Operating profit then takes off the cost of running the business, and net profit includes financing costs and an estimate of Corporation Tax. Brightside kept 21p of every pound of revenue in April, and that £10,500 flows into retained earnings on the April balance sheet.
Balance sheet example
Brightside's balance sheet at 30 April carries the £10,500 net profit from the P&L above.
Category | Line item | Amount |
|---|---|---|
Assets | Cash at bank | £60,500 |
Trade receivables | £45,000 | |
Prepayments | £5,000 | |
Equipment, net of depreciation | £60,000 | |
Total assets | £170,500 | |
Liabilities | Trade payables | £25,000 |
VAT, PAYE and accruals | £15,000 | |
Loan due within one year | £10,000 | |
Loan due after one year | £30,000 | |
Total liabilities | £80,000 | |
Equity | Share capital | £40,000 |
Retained earnings | £50,500 | |
Total equity | £90,500 | |
Total liabilities and equity | £170,500 |
The statement balances: assets of £170,500 equal liabilities of £80,000 plus equity of £90,500.
Retained earnings tie the balance sheet to April's P&L. Opening retained earnings of £45,000 plus £10,500 net profit, less the £5,000 dividend, give £50,500. No new shares were issued, so share capital stays at £40,000. The dividend reduced equity and cash, but it is not an expense on the P&L.
Trade receivables and prepayments are current assets; equipment is non-current. Trade payables, the VAT and PAYE balances and the loan instalments due this year are current liabilities; the rest of the loan is non-current.
Monthly review checklist
Run this list after each month-end close, before you read the numbers. A statement built on unreconciled accounts is not worth interpreting.
Reconcile every bank, card and payment-processor account to the statement balance at month-end, and clear old unpresented items and unexplained differences.
Agree receivables and payables to the aged debtor and creditor reports. Review overdue invoices, unallocated payments and bills falling due.
Check stock and fixed assets. Reconcile stock to its records, and post asset purchases, disposals and depreciation.
Review prepayments and loans. Confirm the month's share of prepaid costs has been released, and that loan balances match the lender's schedule.
Check accruals and tax balances. Compare payroll accruals with the payroll run, and confirm the VAT and PAYE balances agree to the returns filed or due.
Post adjustments and review the trial balance. Then produce the final P&L and balance sheet, and confirm net profit has updated retained earnings and the balance sheet balances.
Compare with last month and with budget. Write down the reason for each material variance in revenue, gross margin, expenses, receivables, debt and equity.
Look across several months. Recurring margin slippage, costs growing faster than revenue, or receivables growing faster than sales show up in the trend before they show up in one month.
What warrants a closer look
Treat an unusual change as a question, not proof that something is wrong. Compare the month with the prior period and the budget, then check the trend over several months. No single percentage fits every business, because seasonality, growth stage and cost structure all shape normal variation.
Gross margin has fallen for several months in a row. Ask whether pricing, discounts, supplier costs, contractor efficiency or sales mix changed. A repeated squeeze matters more than one uneven month.
Operating expenses are growing as fast as revenue, or faster. Find which accounts rose and whether they support planned growth. Separate recurring costs from one-off purchases.
Revenue is still rising, but more slowly. Ask whether volume, pricing, customer retention or capacity explains the slowdown.
Net profit looks healthy while operating profit looks weak. Interest received, an asset sale or a tax refund can hide weak core trading.
Trade receivables are rising faster than revenue. Check the aged debtor report for overdue invoices, disputes or customers paying more slowly. It is usually a collections problem, and it is where cash goes missing.
Liabilities are rising without matching asset growth. Ask what the borrowing paid for, and whether it bought an asset or covered expenses.
Equity is shrinking. Separate trading losses from dividends and drawings, then confirm retained earnings reflect both correctly.
Set your own thresholds around budget, normal monthly variation and the decisions you need to make. Consistent misses deserve more attention than a single variance.
Where cash flow fits
The cash flow statement is the third core statement. It reconciles net profit with the change in cash, which is why a profitable month can still leave less money in the bank: customers paying late, a VAT bill, a loan repayment or a dividend all move cash without touching profit. This guide covers the P&L and balance sheet; the balance sheet's cash and receivables lines are where the cash story starts.
Getting the statements on time
The checklist above assumes the books are reconciled when the month closes. That is the hard part. Software with AI features speeds up matching, but someone still has to clear the exceptions; our guide to AI bookkeeping services explains who does that work under each model, and the fixed-price bookkeeping guide covers what a monthly fee should include.
Balance is an AI-powered accounting firm in London and Copenhagen. Its AI agents reconcile transactions and match documents continuously through the month, and a named ACA-qualified accountant reviews and signs off the finished books, so the P&L and balance sheet are ready soon after month-end rather than weeks later. Bea, Balance's AI finance assistant, answers plain-language questions about them on Slack, WhatsApp or email: why gross margin fell, why receivables went up, what is still unreconciled. When a question needs judgement, Bea passes it to your accountant.
If you want reviewed statements every month without doing the bookkeeping yourself, see what is included or book a 15-minute call.
FAQ
What is a profit and loss statement?
A profit and loss statement, also called an income statement, reports revenue, costs and the resulting net profit or loss over a defined period, such as one month, one quarter or a financial year.
What is a balance sheet?
A balance sheet shows a company's assets, liabilities and equity at one date. Unlike a P&L it is a snapshot, not a record of activity over a period.
How do a P&L and balance sheet connect?
Net profit from the P&L increases retained earnings in the equity section of the balance sheet. Closing retained earnings equal opening retained earnings plus net profit, minus dividends or owner drawings.
How often should you review a P&L and balance sheet?
Monthly, once the books are reconciled, with a longer look at the trend each quarter. A monthly rhythm catches changes while the transactions behind them are still fresh.
Is profit the same as retained earnings?
No. Profit is one period's result. Retained earnings are the cumulative profits kept in the business after dividends and drawings, built up over every period since the company started.
Why must a balance sheet balance?
Because liabilities and equity are the two sources that fund every asset the business holds. If assets do not equal liabilities plus equity, a transaction has been posted to one side only, and the bookkeeping needs correcting before the statements are read.
Are the statements different in the UK and Denmark?
The structure is the same. UK limited companies file annual accounts with Companies House; Danish companies file an annual report with the Danish Business Authority and must keep their books in a system that meets the Danish Bookkeeping Act. Balance works in both.
More answers are on our FAQ page.